BAWAG-PSK Martin LOEFFLER and Daniel BOESHERTZ (1)

State aid

Enforcement of State aid control in the banking sector: BAWAG-PSK Martin LOEFFLER and Daniel BOESHERTZ (1)

On 27 June 2006 the Commission decided to customers. On 31 December 2005, the balance approve a State guarantee of € 900 million granted sheet total was € 57.9 billion with savings depos- to BAWAG-PSK by Austria (). The guarantee pro- its of around € 18 billion. BAWAG-PSK holds a vided collateral for specific bad loans with the con- strong position as a principal provider of banking sequence that the assets remained valuable and no services to the public sector. Governmental trans- value adjustments had to be carried out. fers and wage pay-outs to public employees are handled by the Bank. The Bank has also expanded The exit of inefficient firms is a normal part of the internationally with branches, subsidiaries or par- operation of the market. Therefore, the provision ticipations in the Czech Republic, Slovakia, Slove- of rescue or restructuring aid to firms in diffi- nia, Hungary, Malta and Lybia. The bank’s history culty may only be regarded as legitimate subject goes back to 1922 when a “Bank for workers” was to certain conditions. The Commission authorizes founded for managing the financial assets of the restructuring aid only under the following condi- unions. Until 2006, BAWAG-PSK was indirectly tions: wholly owned by the Austrian federation of trade i) a restructuring plan, which must be endorsed unions (“ÖGB”). by the Commission, has to be prepared, and fully The economic difficulties of BAWAG-PSK resulted implemented, restoring the firm’s long-term via- mainly from two specific sources, the “Carib- bility (without additional aid). bean“ and “Refco“ transactions, conducted by ii) Compensatory measures must be taken in some members of the management. These trans- order to ensure that the adverse effects on trad- actions were made possible because of insufficient ing conditions are minimized as much as possible, risk controlling and the circumvention of existing so that the positive effects pursued outweigh the control instances by the participants. adverse ones. In addition, the Commission may The “Caribbean” transactions were primarily impose any conditions and obligations it consid- conducted between 1995 and 2001. Considerable ers necessary in order to ensure that the aid does funds were used in order to speculate on currency not distort competition to an extent contrary to exchange rates. The invested funds were nearly the common interest. totally lost because the anticipated development iii) The amount and intensity of the aid must be did not take place. From 2001 onwards up to limited to the strict minimum of the restructur- October 2005, the losses were often restructured ing costs necessary to enable restructuring to be and reduced by partial write-offs. The business undertaken in the light of the existing financial relationship of BAWAG-PSK with the bankrupted resources of the company, its shareholders or the US broker Refco, which took place over 1998-2005, business group to which it belongs. consisted mainly in a participation of BAWAG- PSK in Refco, cooperation between BAWAG-PSK 1. Background and Refco in several areas and the granting of loans from BAWAG-PSK to Refco. In April 2006, BAWAG-PSK is the fourth largest bank in Austria. complaints were filed against BAWAG-PSK in It is active in all areas of financial services in Aus- the USA by Refco, the Refco’s creditors commit- tria and abroad. It operates the largest centrally tee, the Department of Justice and the Securities managed distribution network in the country, has and Exchange Commission. During the course of 1.2 million private and more than 60,000 business these proceedings, a large amount of money was frozen by court order until a settlement was nego- (1) Directorate-General for Competition, unit D-3 and tiated with the authorities of the United States and unit F-3 .The content of this article does not necessa- with the Refco creditors. The relationship with rily reflect the official position of the European Com- Refco resulted in total expenses and provisions of mission. Responsibility for the information and views expressed lies entirely with the authors. The authors approximately € 1 billion for BAWAG-PSK. want to thank the other members of the case team, In October 2005, BAWAG-PSK was hit by the namely Vincent VEROUDEN (Chief Economist Team) and Jürgen FOECKING (Unit A3). insolvency of Refco and, at the same time, the (2) Commission Decision of 27.06.2007 in case C 50/2006, losses of the „Caribbean” transaction came to light. BAWAG-PSK. These events led to value adjustments requiring

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the provisioning of an amount which could not be ibility of the restructuring aid with the common STATE AID brought by the Bank’s own resources. Alerted by market and opened the formal investigation pro- the press, depositors massively withdrew money cedure() in November 2006. from current and savings accounts in late April/ The Commission considered that no market opera- early May 2006. Globally, the current and savings tor would have granted the guarantee to BAWAG- accounts held by the bank were reduced by several PSK, which was a firm in difficulty at that time, billion euros. for a fee of 0.2%. As a consequence, the State guarantee conferred an advantage on BAWAG-PSK. 2. The State guarantee Furthermore the guarantee was granted by Aus- On 8 May 2006, in order to stop the bank run and tria on 8 May 2006, with retroactive effect from 31 to secure the liquidity of the bank, Austria granted December 2005, before the Commission decided by law a guarantee for receivables of BAWAG-PSK on its compatibility. As a consequence, the Com- for a amount of € 900 million. Without the guar- mission concluded that the guarantee provided to antee, BAWAG-PSK would not have been able to BAWAG-PSK was an illegal State aid (). comply with the solvency and equity capital pro- The subsequent investigation under the Com- visions of the Austrian Banking Act and therefore munity Guidelines on State Aid for Rescuing not able to close the 2005 annual accounts. and Restructuring Firms in Difficulty () mainly The conditions of the guarantee obliged the own- focussed on two issues: ers of the Bank to sell their shares in BAWAG-PSK i) the aid element involved in the guarantee, and to an independent third party within one year. The guarantee would end 60 days after BAWAG- ii) the compensatory measures, i.e. the measures PSK was sold but, in principle, not later than 1 July to mitigate the distortive effect of the aid on 2007. An extension under certain conditions was competition. however possible. 3.1. Assessment of the aid element in the The guarantee of Austria could only be drawn State guarantee if, cumulatively, i) BAWAG-PSK was not sold, ii) BAWAG-PSK, its direct and indirect sharehold- The specific nature of the guarantee ers had been requested to pay and to disclose their financial situations and obliged to pay up to the In order to determine the aid element in the guar- limit of their capacities for payment before the antee, the Commission had first to consider the guarantee could be called on, iii) the economic specific nature of the guarantee granted by Aus- threat to the bank continued to exist and iv) an tria. insolvency of the Bank threatened or has already The guarantee provided collateral for specific occurred. The drawdown of the guarantee was also non-performing loans of the Bank. The conse- permitted if insolvency threatened only because quence was that the assets remained valuable and the guarantee would expire on 1 July 2007; the no value adjustments, which would have gener- Federal Government could avoid the drawdown ated additional losses of € 900 million in the 2005 under the guarantee by extending it. However, accounts, had to be carried out. BAWAG-PSK’s this required an additional decision by the Federal core capital ratio could thus be prevented from Government. decreasing below the minimum statutory require- The fee to be paid by BAWAG-PSK was fixed at ments. In this regard, the effect of the guarantee is 0.2% per year for the period ending 30 June 2007 similar to that of a capital injection. and 1.2 % afterwards. Moreover, the guarantee is not comparable to guarantees securing the liabilities of a bank (). In addition to the State guarantee, two special Such guarantees provide direct claims to the purpose vehicles (“SPV”) were created by private creditors of the bank. In the case of insolvency, the banks on the one hand and insurance companies guarantor has to meet the liabilities, which cannot on the other hand, which enabled BAWAG-PSK to increase its eligible capital by € 450 million. (3) OJ C 232, 30.12.2006, p. 11. The scenario of a sale of BAWAG-PSK to a third (4) i.e. an aid which is implemented before the adoption of party formed the basis of the restructuring plan the Commission decision authorizing it. The fact that an aid is illegal does not mean that it is incompatible with submitted by Austria in September 2006. the common market. (5) OJ C 244 of 01.10.2004, p.2. 3. The in depth enquiry (6) Compare case C- 30/1996 Commission decision of 23 June 1999 conditionally approving aid granted by France to Following a preliminary assessment, the Com- Crédit Foncier de France (notified under document num- mission had doubts as to the legality and compat- ber C(1999) 2035) (OJ L 34, 3.2.2001, page 36, para. 49).

Number 3 — 2007 107 State aid be satisfied from its assets. Economically, this guarantee was granted, the future development type of guarantees reduces the cost of refinancing of BAWAG-PSK was not predictable. The situa- of the bank via debt/bonds. In guaranteeing the tion of BAWAG-PSK in the end of April 2006, a recoverability of about 1.6 % of the total assets of few days before the Federal Chancellor declared the Bank in the deficiency case, the guarantee had in a press conference that Austria would issue a also a limited indirect effect on the security of the guarantee, was very critical and the reactions by liabilities but the overall impact of the guarantee the clients and partners were extremely threat- can not be considered as comparable. ening for the Bank. A run on the branches of the Bank had started, which took on a scale without The aid element depends essentially on the future precedent in recent Austrian history. This situa- sale price tion created a major danger for the liquidity of the Bank. A continuation of the development for even A key condition for the granting of the State a short period of time would have had lethal con- guarantee was the commitment by ÖGB to sell sequences for the Bank. BAWAG-PSK to independent third parties. It appeared quickly in the assessment that the aid In this context, the Commission has come to the element was directly connected to the expected view that: sales price. Indeed, the recoverability of the claims i) the timing of the sale and the level of the pur- that BAWAG-PSK had against its shareholders chase price of BAWAG-PSK were unknown depended on the latter’s ability to repay their debt. variables, bearing very important risks for a It was agreed that the sales price payment has to market oriented guarantor; be used in the following order: first, to satisfy any ii) the time constraints were increasing to a very rights of third parties and claims against the own- significant extent the difficulty for an opera- ers under the “Refco”-settlement in the US, sector to intervene; ondly to pay all remaining liabilities owed by the direct and indirect owners, and thirdly to reduce iii) the intrinsic value of the Bank was not so low the guarantee of the Republic of Austria. Any as to fully exclude that a market guarantor reduction of the sales price below the sum of the would have granted the € 900 million, how- remaining liabilities and the amount of the guar- ever conditioned on the high fees. antee (“threshold price”) would have triggered the As a consequence, the Commission has concluded guarantee in the absence of additional equity sup- that the aid amount involved in the guarantee port or short term reductions of risk assets. could only be estimated within a range. The upper At the time the guarantee was granted, three value of this range is € 898 million, i.e. the nomi- major scenarios would have been considered by a nal value of the guarantee minus the guarantee fee market operator: of 0.2% paid by the Bank. Fixing the lower value is the most complex; the Commission has estimated i) the sale of the Bank at a price above the that this lower value is at least two thirds of the threshold price with the consequence that the nominal value of the guarantee. guarantee could have been abolished the day of the closing without being drawn; Additional considerations ii) the sale of the Bank at a price below the The objective of the granting of the guarantee threshold price with the consequence that the reflected the interests of Austria, which was to guarantee had to be drawn fully or partially; re-establish the trust of the investors and part- iii) the sale of BAWAG is not achievable. In this ners in the stability of BAWAG-PSK and the latter scenario the guarantee has to be pro- financial sector in Austria and to avoid an alleged longed until the owner is able to execute the disproportioned large damage for the Austrian required capital injection or BAWAG-PSK economy (). itself has generated the necessary capital reserves. These objectives are not in line with the intrinsic interests of a market investor, which are to max- The Commission was not able on the basis of the imise the return (taking into account the level of available information to determine precisely the risk acceptable for a given rate of return), to take probability of each scenario (). At the time the (8) However, the Commission has considered that Austria (7) The fact that ÖGB sold BAWAG-PSK to a consortium led has not demonstrated that BAWAG-PSK’s insolvency/ by the U.S. private equity group Cerberus Capital Mana- bankruptcy would have had systemic implications on gement L.P. in December 2006 could not be considered the Austrian financial system and, more globally, on the in the Commission’s assessment because it has only to whole Austrian economy. The Commission therefore consider what would have been known by a potential has decided that Article 87(3)(b) is not applicable in the investor in April/May 2006. present case.

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control of or significant influence in the Bank and by the Commission because they take place in STATE AID to use the decision- making power to succeed the markets where the Bank will have significant turn around. market position after restructuring and go beyond anything necessary to restore viability. Further- Furthermore, where an undertaking in difficulty more, as a condition for the granting of the State needs financial support and is not able to pay an guarantee, BAWAG-PSK had to sell its shares in appropriate remuneration in the short term, a the Austrian National Bank; this participation was guarantee including the payment of an annual fee of real significance for the Bank. Moreover, shares is technically not the appropriate instrument. The in Bank Frick & Co. AG and Hobex AG have been negative impact of a considerably high fee would sold. By selling its participation in Hobex, which have threatened the success of the reorganization is active in debiting authorization, BAWAG-PSK and the continuation of the Bank. withdrew from an important sector, where the Finally, a private investor would have been more most important banks are present in Austria. prone to intervene with a capital injection, which While 3 branch offices in Vienna are to be closed, would have given a stake in the Bank, and decision the Commission has not considered this closure as making power to ensure success of the restructur- an effective compensatory measure because it has ing. However, according to both the Commission not been demonstrated that the relevant branches and Austria, no private investor would have been are not loss-making activities which would have willing to provide funds which would be consid- to be closed at any rate to restore viability. ered as equity capital (). Besides, the Bank has also undertaken to sell the 3.2. Compensatory measures essential part of its non-core business activities. The Community Guidelines on State aid for res- Finally, no aid other than that referred to in cuing and restructuring firms in difficulty state Art. 87 (2) of the EC Treaty, or aid granted under that measures must be taken to mitigate as far as research projects jointly financed by the European possible any adverse effects of the aid on competi- Union, or aid to general training within approved tors. The measures must be in proportion to the schemes, or aid for energy savings within approved distortive effects of the aid and, in particular, to schemes, can be granted to BAWAG-PSK for a the relative importance of the firm on its market given period of time. or markets. The divestment, closure and other measures will In exchange for obtaining the approval, in addi- lead to a substantial reduction of BAWAG-PSK tion to the commitment by its former owner ÖGB business volume, which is consistent with the to sell BAWAG-PSK, Austria submitted several Commission’s practice regarding restructuring other commitments to divest assets, reduce capac- aid for banks (10). ities or market presence. Some divestments were included in the restructuring plan and had already 4. Conclusion taken place, for example the sale of the shares in Voestalpine AG. Additional commitments were This decision is important as it sets a compre- also adopted, for example the sale of a 50% share hensive reasoning on how State guarantees are in PSK and BAWAG insurances, the sale of con- addressed by the Commission in a State aid per- siderable real estate assets and the sale of its hold- spective. ings in ATV Privat-TV Services AG. Thanks to a series of intensive negotiation rounds In its core business, BAWAG-PSK agreed to reduce with Austria and the new owners in spring 2007, the volume of its loans to the Federal Republic of the aid could be approved 7 months after the open- Austria for a given period of time and committed ing of the formal investigation procedure. to temporary refrain from participating in tender Following the closing of the sale of BAWAG-PSK procedures in which the Republic of Austria seeks to the Consortium on 15 May 2007, the guarantee to commission so-called Primary Dealers to issue was abolished and the private banks and insur- bonds for the Federal Republic. These two meas- ance companies were entitled to terminate the ures have been regarded as particularly relevant respective SPV.

(10) See for instance the Commission decisions in Crédit Lyonnais (Case C 47/1996 Commission Decision of 20 May 1998 concerning aid granted by France to the Crédit Lyonnais group (OJ L 221, 8.8.1998, page 28)) and (9) The setting up by private operators of the two SPVs does Bankgesellschaft Berlin (Case C 28/2002 Commission not invalidate this assessment as the SPVs would not decision of 18 February 2004, C(2004) 327, Bankgesell have been created in the absence of the guarantee. schaft Berlin (OJ L 116, 4.5.2005, page 1)).

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